Monthly Archives: August 2010

ROI, ROIC, ROCE, and … ROSMA?

The key to a rising CPO’s success is the often the ability to talk shop with the CFO and explain the advantages of supply chain management in terms that the CFO can understand. It’s often the quickest way to a seat at the boardroom table. Traditionally, this has come down to the ability to provide the CFO with the ROI (Return on Investment), the ROIC (Return on Invested Capital), and the ROE (Return on Equity) of every investment. This is because ROI measures the efficiency of investment, the ROIC measures the company’s efficiency at allocating the capital under its control to profitable investments, and the ROE measures the profitability of the investment. But will CPOs soon have to add another measure to their financial lexicon?

Near the end of A.T. Kearney’s Higher Visibility, Greater Expectations that chronicled the results of their recent Indirect Procurement study, they discuss their new approach to translate the business case into a language more recognizable to finance executives which revolves around their new ROSMA (Return on Supply Management Assets) metric. Now, it sounds good … because what could be better than a financial metric (which gets a CFO excited) specifically designed to showcase the performance of supply management … but does it deliver?

Breaking it down, A.T. Kearney defines ROSMA(c) as financial results delivered / invested supply management assets where the financial results are the product of spend coverage, velocity, category yields, and compliance plus the net extended benefits and the invested supply management assets are the sum of period costs and structural investments. This sounds logical, and when you consider that twenty different factors go into the calculation of the financial results and that twelve different factors go into the calculation of the invested supply management assets, it sounds complete, but it is sound. And more importantly, will CFOs bite?

To answer this question, I’ve invited Robert Rudzki, SI’s resident expert on supply chain finance (and [co-]author of Beat the Odds: Avoid Corporate Death and Build a Resilient Enterprise, On-Demand Supply Management, and the supply management best seller Straight to the Bottom Line), to chime in. This is what he had to say:

 

AT Kearney’s ROSMA(c) framework offers another tool to connect the supply management function with its colleagues in the financial function. As a former practitioner with a dual background in finance and supply management, I appreciate the applicability of the concept. I do have a few specific questions; for example, does “supply management assets” include the assets participating from other functions outside of supply management? If so, then ROSMA(c) appears to be a comprehensive framework that can withstand the scrutiny of the toughest bean counters.

The more fundamental question however is this: do we really need a another framework, or do we just need to do a better job connecting to the financial metrics that are already being used by the CEO and CFO to manage the business?

In our experience, CPOs can dramatically improve their internal credibility with the executive staff by relating their proposed agenda (including the need to transform supply management) to the metrics that the senior staff and the Board of Directors already monitor. Such key metrics as ROIC / ROE / RONA (Return on Net Assets), cash flow and EPS (Earnings Per Share), are highly visible and relevant metrics. Rather than introduce a new metric, we have generally found it to be more productive — and quicker at achieving credibility — to relate the proposed CPO agenda directly to the particular metrics currently in use by the company’s senior management.

Thanks, Bob!

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Procurement Has a Long Way To Go if Being a Doorstop is a Measure of Success

A few months ago, the CPO Agenda published the transcript for its roundtable in London in May 2010 on budgeting for a wider influence. While this post is not going to summarize the transcript as it really doesn’t say anything that this blog hasn’t been telling you for years, buried within the transcript is a very interesting quote by David Noble, the Chief Executive of CIPS.

If we do not have the ability to get in there and hold the door, we will lose it and be back to where we were 10 years ago.

In other words, a current measure of success is your ability to hold a door, i.e. your ability to act as a doorstop!

It’s sad, but at many companies, it’s still true. Just like there are at least five companies that haven’t tried e-Sourcing or e-Procurement for every one that has, for every best-in-class company where Supply Management has influence and/or control over the majority of the organizational spend, there are five companies where Supply Management doesn’t have influence or control over the majority of organizational spend.

So how do you get more spend under your control and move up from door-stop to door-person? You kick-ass on some major projects and get more and more support from the C-Suite. So how do you get those big projects? You start by speaking the language of finance, because once you get the CFO on your side, the CEO will follow and then you’ll have the credibility you’ll need. Start with Bob’s great posts on Speaking Like a CFO (Part I and Part II). Then review the quick introduction to finance posts (Part I, Part II, and Part III). Make sure you understand what the Z-Score really is. Then bookmark Investopedia. It will be your best friend. Its dictionary on finance more than rivals Wikipedia’s.

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Why ERP Is Not Enough for Project Based Manufacturing

A recent article over on Industry Week on 5 Critical Issues for ERP in Project-based Manufacturing outlined why ERP systems alone are not enough for project based manufacturing (and manufacturing in general).

The issues outlined in the article were:

  1. Bidding and Quoting
  2. Project Visibility
  3. Managing Change
  4. Financial Performance Tracking
  5. Rapid Time to Value

A carefully evaluation of many of the ERP tools on the market will reveal that:

  1. They don’t truly support modern e-Negotiation, and the company will also need a modern e-Sourcing tool (which may have to be integrated).
  2. As far as these systems are concerned, user-defined push alerts, flexible automatic notifications, and real-time reporting is still a pipe dream. A real time data analysis tool will be required.
  3. Flexibility is limited. At a a minimum, good processes will be required. A change management add-on may be required as well.
  4. Lots of data is tracked and stored, but financial analysis capabilities are limited. A real time data analysis tool will be required here as well.
  5. Implementation is rarely quick, and payback typically longer than expected. That’s why supplementary Sourcing and Procurement systems are generally required.

In other words, a good ERP system can provide a great foundation, but it will rarely meet all of an organization’s need.

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A Hitchhiker’s Guide to e-Procurement: Costing a Solution

Mostly Harmless, Part XXI

Previous Post

Every solution costs more than the sticker price. But how much more? In this post, we’ll outline how to cost the various solutions as well as a methodology for calculating the expected value.

First of all there’s the cost of the license, which can be significant. If the system is enterprise, and especially if it’s an installed solution, this can be a very significant up-front cost in the six figure range. Then there’s the maintenance, which is required for support and mandatory for some solutions, and built into the price of on-demand/SaaS solutions. This can be as high as 22% a year for some solutions. Then there’s the installation and integration costs. Even a SaaS solution will require some setup, and the e-Procurement system will need to be integrated with accounting systems, sourcing systems, payment systems, and other enterprise (resource planning) systems in order for the organization to extract maximum value for the system.

Then there’s training costs. Even though a good system will be extremely easy to use and self-explanatory where basic functions are concerned, some training will still be required. This is especially true for the administrators, who have to maintain the system, and analysts, who have to analyze processes, performance, and spending. In addition to training costs, there will be support costs. Administrators will have to be employed to continually maintain the system (data) and train new users. If the system is installed, they will also have to do patches and upgrades in addition to maintaining system data and (business) processes.

If the organization is looking for an installed or hosted ASP solution, there will also be hardware costs, database costs, application server costs, and middleware costs. These costs can easily dwarf the system costs if the organization doesn’t already have any of these solutions. And even if the organization has some of these solutions in place, there will likely be additional license fees. Finally, there will likely be additional IT (support) costs to maintain the hardware, which will have to be upgraded on a regular basis, and the supporting software.

When all is said in done, the cost of a solution can end up being 10 times the sticker price, so it’s important to understand the total cost of ownership before choosing a solution. This is not to say that a solution with a seven figure total cost of ownership is expensive. It might be, it might not. It all depends upon how much it costs relative to other solutions being evaluated, how many users will use the system, how much it will increase organizational efficiency, and what ROI the organization expects to see.

Fortunately, the calculation of expected value is quite straightforward once the TCO is known. It’s simply a matter of computing the ROI according to the following formula:

(savings expected from increased efficiency +savings expected from maverick spend reductions +savings expected from newly identified opportunities) /total expected cost

While some of these numbers may appear hard to calculate, they are easy to estimate and what is really important is order of magnitude. For example:

  • if the organization expects to increase efficiency 200%, that’s a 65% workforce reduction against current workload; if the organization currently requires 20 people to handle tactical procurement tasks, at an average salary of 62K, that’s a reduction of 13 people or about 800K per year
  • if the organization currently has a maverick spend rate of 30% and expects, using third party benchmarks, to reduce that by 66%, that’s an 20% reduction in maverick spend; if maverick spend, on average, costs the organization 5% of spend on average, if the organization spends 100M annually, that’s a projected savings of 1% (20% of 5%), or 1 M in one-time savings
  • if the organization expects that an e-Procurement system will identify additional savings opportunities on 20% of spend annually and that the average savings that will be obtained will be 10%, then the organization would expect to save 2% of spend, or 2M annually

All told, if the organization expects to use the system for five years, it would expect to save 15M over five years (5*800K + 1M + 5*2M). If the total cost of ownership of the system was determined to be 3M for five years, then the organization would expect to see an ROI of 5X, which should be a buy decision. Of course, if the calculations worked out that the organization only expected to save 5 M, and the ROI was only 1.6, the decision should be to find a more cost effective solution.

For more details on cost calculations, and a starting spreadsheet, see Sourcing Innovation’s post on Uncovering the True Cost of On-Premise Sourcing & Procurement Software in the archives.

Next Post: Procurement Models

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The Board Room CPO

In addition to offering insights into planning horizons, supply chain strategy drivers, and keys to supply chain success, the recent report on Supply Chain Strategy in the Board Room by the Cranfield School of Management and Solving Efeso also discussed what it all meant for supply chain leaders of tomorrow. It’s conclusion was that the CPO of tomorrow needs to fit the following profile:

  • Strong Communicator: gravitas within Leadership team

    in many companies, the sourcing / procurement / supply chain leader still doesn’t have a seat at the table, and even when she does, she often reports to the COO, CFO, or another CXO that’s not the CEO

  • Multi-Disciplinary: able to understand corporate & customer service strategy

    without this insight, the CPO will never develop a supply chain strategy that complements and enforces the corporate strategy

  • Collaborative: works as a team player, does “external sensing”

    in modern terms, the CPO must have a high EQ IQ

  • Vision-Led: but practical and pragmatic

    the CPO must be able to think long term, but able to adapt to short-term circumstances and fluctuations

  • Fact-Based: but able to deal with “ambiguity and ambition”

    the CPO must have a solid grasp of true analysis, and apply those skills whenever data are available, but also be able to fill in the gaps with wisdom and experience when data is sparse

  • Culturally-Intelligent: able to deal with a mix of global, regional, and local culture/leadership styles

    modern supply chains are global and they are going to stay that way

In other words, nothing that Sourcing Innovation and other top blogs haven’t been telling you for years, but it’s nice to see more support for the profile.

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